Holiday home – long term tax planning

Published by Jo White on 13 October 2021

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With the overseas holiday market still being a little uncertain, the desire to book a staycation is still strong. A UK holiday home can therefore be a good asset to consider any longer term tax planning opportunities.

By way of example, Ben and his wife Sophie jointly own a holiday home in Devon. They have grown up children and grandchildren and over the years the property has turned from one which they used at peak times with the whole family, to one where they go and stay off peak and let for the rest of the year.

The property is worth £500,000 and was purchased for £250,000. The rental profits per annum average £25,000 and there is no mortgage.

With the holiday home being one of their most valuable assets outside of their matrimonial home, they are concerned about the Inheritance Tax position should they die whilst holding it. They are also aware that with the appetite for staycations growing, property prices in neighbouring towns have increased considerably.

They have two options to consider; the first is to gift the property to their children. Providing they survive seven years from the date of the gift, then the value will fall completely outside of their estate. More importantly, any increase in the property value from the date of the gift will automatically be outside of their estate. However, Capital Gains Tax (“CGT”) would be payable based on a gain of £250,000. The tax liability being as much as £63,000 and payable within 30 days of the property being transferred.

Ben and Sophie are concerned about the children owning the property in their own names. The use of a trust is therefore a good option for them. By transferring the property into a trust, they can maintain control over the property, but the family can benefit from its use and the income. It is possible to limit the class of beneficiaries and who can ultimately benefit from the asset.

As the property is owned jointly and is worth less than £650,000 then the whole property can be transferred into trust without an immediate Inheritance Tax charge. They may also decide to transfer some cash to help with the maintenance of the property should they feel it is needed. The same seven year rule applies to this option as it does for an outright gift. Although a CGT is triggered on transferring the property into the trust, this can be deferred where the appropriate elections are made.

Once the property is in the trust, the income can be used either for the benefit of their children, or help pay for the grandchildren’s costs, such as school fees or university costs. Where income distributions are made to the grandchildren, and they have little or no other income, any tax paid by the trust can be reclaimed by them meaning the income can be tax-free.

As Ben and Sophie will want to continue to stay in the property it is important that they pay commercial rent for its use when they stay there. If they don’t then the gift will not be valid for Inheritance Tax purposes.

Longer-term, even if property prices do not increase, this planning could save the family £260,000 in Inheritance Tax, versus retaining the property in their own names. The CGT liability of £63,000 has been deferred and there is the potential for the rental income to be tax free.

For more information on the topic explored in this article, contact us here.

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